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Active ETFs Leverage Options for Alpha

Investors poured more than $1 trillion into ETFs for the first time last year. While most investors focus on low-cost ETFs tracking major indices, many asset managers have set their sights on more complex active strategies. According to Morningstar, about 10% of the record haul went into active ETFs, which saw more than 200 new funds launched throughout the year.

A growing number of active ETFs use complex strategies to generate alpha, including complex options strategies. For example, covered call ETFs have provided investors with above-average income by writing call options on major indexes for years. However, newer techniques aim to mitigate risk and amplify upside, entering new territory.

Let’s look at how active ETFs are increasingly leaning on options to deliver above-market income and returns.

See our Active ETFs Channel to learn more about this investment vehicle and its suitability for your portfolio.

Popular Options Strategies

Options provide asset managers with countless new opportunities. For example, a long call option provides significantly more leverage than a long stock position. Combining different options at different prices or expiration dates makes it possible to create precise strategies that leverage upside, limit downside or generate income.

Popular options strategies include:

  • Covered calls involve selling a call option against a long stock position to generate income. Of course, the call option limits potential upside, creating a trade-off.
  • Married puts involve buying a put option alongside a long stock position to add downside protection. However, the cost of the put option may offset gains.
  • Protective collars involve purchasing out-of-the-money put options and writing out-of-the-money call options on an underlying asset to limit losses.
  • Long straddles involve simultaneous purchase of a put option and a call option on the same underlying asset, creating a directional bet that amplifies gains.

Of course, investors should keep in mind that options come with greater risk. While options-based ETF asset managers are typically experienced with options, options inherently add cost to mitigate potential downside or incur risk to leverage potential upside. And, when generating income, investors generally are sacrificing some upside potential.

New Options-Focused Funds

Global X launched six new options-based ETFs last year. These funds leverage options to achieve specific outcomes, such as generating income in a low-yield environment and managing downside risk amid bouts of elevated volatility. They pair with either the Nasdaq 100 or the S&P 500 index to provide broad exposure to the market.

 
Source: Morningstar

Simplify also launched new funds with its options-heavy approach. These funds focus on convexity to amplify potential upside and mitigate potential downside using out-of-the-money options. In addition, the asset manager has an ETF with extreme convexity to protect portfolios against a severe sell-off in the equity market.

 
Source: Morningstar

Don’t forget to explore our Dividend Guide where you can access all the relevant content and tools available on Dividend.com based on your unique requirements.

The Bottom Line

Active ETFs are becoming increasingly popular, and many asset managers are turning to options to unlock new possibilities. As a result, investors may want to look at these strategies to leverage upside, mitigate risk or generate income in their portfolios, particularly in today’s low-rate and high-volatility environment.

Take a look at our recently launched Model Portfolios to see how you can rebalance your portfolio.

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Jan 21, 2022